Dr. Don, Two weeks ago my 22-year-old son received a judgment from a lawsuit for $850,000. He has graduated from college and is working, making an annual income of about $30,000. He has no debt and currently has the money invested in a money market fund. I have suggested dollar cost averaging one-third of it into mutual funds over a two-year period, one-third into the bond market and the other one-third to remain in the money market fund. Any suggestions, or is this OK for the present? Thank You, D.C.

D.C.,

Your question is a great one because investors face this problem all the time when deciding how to invest a lump sum. If your son plans on putting one-third of his money in the stock market and one-third in the bond market, should he do it all at once, or invest it in chunks over a time horizon?

Dollar cost averaging is a disciplined approach to investing. With dollar cost averaging, you invest the same amount of money periodically in an investment. When the investment is selling at a high price, you buy less of the investment, and if it is selling at a low price, you are able to buy more. The idea is that by not letting your opinion of an investment's being cheap or pricey influence how you buy, you buy in at the investment's average cost over the accumulation period.

It's more common for investors to use dollar cost averaging in contributing to retirement accounts, or adding to a core holding in the portfolio. The money that the investor is using to pay for his investments isn't coming from his portfolio, it's coming from his income. He's contributing additional dollars to the investment portfolio. Although it reads like I'm splitting hairs, the difference in approach is substantial.

If you contribute $200 each pay period into a 401(k) plan, and the money is allocated to four mutual funds, you're dollar cost averaging. The number of fund shares you buy depends on the richness or cheapness of the funds' current valuations. The income you're investing has come as a return on your labor over the past pay period.

When you dollar cost average in a lump sum investment, the wealth already exists in your portfolio. You're just deciding when and how that wealth will be reinvested. So you're handicapping the outcome of the markets over the period that you will be investing the funds, even as you dollar cost average into the investments.

If the investment's price trends higher over your investment period, you would have been better off investing the lump sum up front. Conversely, if the price trends lower over your investment period, you would have been better off staying in cash. Dollar cost averaging is the middle ground, because it lessens your losses if the price trends lower but allows you to participate, albeit not fully participate, in the investment's gains if the price increases over the investment period.

Morningstar's

University has a course in its mutual fund curriculum, Course 106: Methods for Investing in Mutual Funds. The course talks about some of the benefits associated with dollar cost averaging, but also introduces the idea that you can invest part of the money as a lump sum and invest the balance using dollar cost averaging. This approach works well for investors with longer-term financial goals. The university is also a great way to learn about investing. You can even earn credits that you can spend in the college bookstore.

More important than how to invest the lump sum is: What financial goals does your son want to achieve with this money? If the goals are long term, like retirement, he should be willing to accept more volatility in the portfolio and dollar cost averaging over a two-year period really isn't necessary.

If there are also short-term needs or goals, then keeping some money liquid to meet those goals becomes important and cash becomes more important. But in the absence of short-term financial needs or goals, allocating the investments in equal measure in stocks, bonds and cash is a very conservative investment strategy.

A conservative investor is concerned about preserving wealth but also needs to be concerned about preserving that wealth's purchasing power. Long-term, cash investments struggle to keep pace with inflation, especially on an after-tax basis. To commit one-third of the portfolio to cash puts additional pressure on the balance of the portfolio to provide an investment return that will increase the purchasing power of the portfolio.

Treasury inflation indexed, or TII, securities and Series I Savings Bonds have an inflation component built into their return. Investing in these securities will provide a reasonable hedge against inflation, although the taxation of investment returns on the TIIs makes them unattractive for most taxable accounts.

Keeping the stock investments well diversified is another important part of managing the portfolio's risk. It's not just what percentage of the portfolio is allocated to stocks; it's also what stocks are purchased. Investing in a diversified stock portfolio reduces volatility (risk) and allows the investor to be a little less concerned about market timing when investing a lump sum.

Rather than dollar cost averaging a bond portfolio, to achieve diversification your son can invest in a laddered bond portfolio. A laddered bond portfolio invests in different maturities out through a final maturity. The individual bonds are like the rungs on a ladder. As the nearby bond matures, you buy a new bond of the longest maturity. With this approach, you get around the temptation to try to predict interest rates.

Putting it all together, deciding how he wants the portfolio to help him attain his financial goals will help determine the appropriate asset allocation for the portfolio. There's nothing wrong with using a dollar cost averaging approach when investing a lump sum, but the further out his goals are, the less necessary that approach is to successful investing. Diversification within the asset classes is important, too, because it also helps to reduce the risk of the portfolio.

Finally, being comfortable with how this money is being invested is very important. If he needs help with putting together his financial goals and a budget, consulting with a financial planner would be money well spent. I recommend that he start with a fee-only planner to set up an initial investment plan before deciding whether the assets need to be managed by a professional. This link provides you with

10 questions to ask when you're interviewing a financial planner.

Dr. Dr. Don Taylor has been an investment professional for nearly 15 years, most recently as the treasurer for a nonprofit organization where he managed more than $300 million in assets. He is a chartered financial analyst, holds a Ph.D. in finance and has taught investment and personal finance courses at the University of Wisconsin and at Florida Atlantic University. Dr. Don's Portfolio Rx aims to provide general investing information. Under no circumstances does the information in this column represent a recommendation to buy or sell. Dr. Don welcomes your inquiries and feedback at

portfoliorx@thestreet.com .